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Using real options to evaluate ethanol plant expansion decisions


  • Glenn Pederson
  • Tianyu Zou


Purpose - The purpose of this paper is to investigate how to incorporate market price risk into investment decisions. The investigation focuses on investments to expand ethanol production facilities. The model is used to determine if such a real option approach can explain recent changes in the level of plant investment activity. Design/methodology/approach - The paper demonstrates how real option analysis and Monte Carlo simulation can be used to evaluate ethanol plant investments by using available historical industry and market price data. We focus on existing small-to-medium, dry milling plants and the real option to expand the scale of operations. The binomial option pricing model is used to identify optimal strategies. Findings - Increasing profitability and volatility appear to favor the strategy of investing during 2005-2007. However, when the prices of corn and natural gas rise and plant profitability declines during 2007-2008, the best strategy is increasingly to either postpone the investment or reject the decision to expand. Originality/value - This paper is a first application of real option analysis to ethanol plant expansion decisions. The methodology used in the paper can be adapted by analysts, investors, and lenders in the ethanol industry to improve their investment analyses.

Suggested Citation

  • Glenn Pederson & Tianyu Zou, 2009. "Using real options to evaluate ethanol plant expansion decisions," Agricultural Finance Review, Emerald Group Publishing, vol. 69(1), pages 23-35, May.
  • Handle: RePEc:eme:afrpps:v:69:y:2009:i:1:p:23-35

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    References listed on IDEAS

    1. Ashok Mishra & Hisham El-Osta, 2008. "Effect of agricultural policy on succession decisions of farm households," Review of Economics of the Household, Springer, vol. 6(3), pages 285-307, September.
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    4. Minna Väre, 2006. "Spousal Effect and Timing of Retirement," Journal of Agricultural Economics, Wiley Blackwell, vol. 57(1), pages 65-80, March.
    5. Marcel A.P.M. van Asseldonk & Miranda P.M. Meuwissen & Ruud B.M. Huirne, 2002. "Belief in Disaster Relief and the Demand for a Public-Private Insurance Program," Review of Agricultural Economics, Agricultural and Applied Economics Association, vol. 24(1), pages 196-207.
    6. Novak, James L. & Gentle, Paul F. & Duffy, Patricia A. & Keefe, Alison M., 2005. "Farmers and Social Security Reform," Choices, Agricultural and Applied Economics Association, vol. 20(2).
    7. Ayal Kimhi & Ramon Lopez, 1999. "A Note on Farmers' Retirement and Succession Considerations: Evidence from a Household Survey," Journal of Agricultural Economics, Wiley Blackwell, vol. 50(1), pages 154-162.
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    Cited by:

    1. Xian, Hui & Colson, Gregory & Mei, Bin & Wetzstein, Michael E., 2015. "Co-firing coal with wood pellets for U.S. electricity generation: A real options analysis," Energy Policy, Elsevier, vol. 81(C), pages 106-116.
    2. Azadeh, Ali & Vafa Arani, Hamed, 2016. "Biodiesel supply chain optimization via a hybrid system dynamics-mathematical programming approach," Renewable Energy, Elsevier, vol. 93(C), pages 383-403.
    3. Calum G. Turvey, 2010. "Biography: Kiyosi Itô and his influence on the study of agricultural finance and economics," Agricultural Finance Review, Emerald Group Publishing, vol. 70(1), pages 5-20, May.
    4. repec:eee:eneeco:v:65:y:2017:i:c:p:434-441 is not listed on IDEAS
    5. McCarty, Tanner & Sesmero, Juan, 2014. "Uncertainty, Irreversibility, and Investment in Second-Generation Biofuels," 2014 Annual Meeting, July 27-29, 2014, Minneapolis, Minnesota 179201, Agricultural and Applied Economics Association.
    6. Andreas Welling, 2017. "Green Finance: Recent developments, characteristics and important actors," FEMM Working Papers 170002, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
    7. Tubetov, Dulat & Maart, Syster Christin & Musshoff, Oliver, 2012. "Comparison of the investment behavior of Kazakhstani and German farmers: An experimental approach," 2012 Conference, August 18-24, 2012, Foz do Iguacu, Brazil 125218, International Association of Agricultural Economists.
    8. Awudu, Iddrisu & Zhang, Jun, 2013. "Stochastic production planning for a biofuel supply chain under demand and price uncertainties," Applied Energy, Elsevier, vol. 103(C), pages 189-196.


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